Oil Industry’s Half-Price Sale May Be Poised to Burn Itself Out

Oil producers became fugitives from the law of supply and demand in 1998 as oil and gasoline prices plunged to historic lows and layoffs rose to levels not seen in more than a decade.

The world is still splashing through an oversupply of crude, and the oil industry and oil-producing countries may have months of suffering yet to endure. But the half-price sale actually may be nearing an end, industry experts predict.

That’s because, as denizens of the oil patch like to point out, the surest cure for cheap oil is cheap oil.

Low prices have led the big companies that explore for oil and natural gas to slash spending plans, which will translate into lower production. Smaller, independent producers are running out of money and shutting down wells, which also means that less oil will be produced. And the Organization of Petroleum Exporting Countries is getting ready to meet next month, with production cuts expected to be high on the agenda.

Such reductions in supply, coupled with potential slight increases in demand, could eventually pull oil out of the $10-to-$12-a-barrel swamp it has been wallowing in for months.

“There’s an old Arab adage: One drop too little is a shortage, and one drop too much is a glut,” said Albert J. Anton Jr., a partner in Carl H. Pforzheimer & Co., a Wall Street investment firm that specializes in energy. “This is an industry that lives at the increment, and a lot of it has to do with perception.”

The perception these days is that oil can’t get much cheaper. It can, of course, if swooning Latin American economies sink even lower, or if prospects become even more dismal for Japan or Russia, or if Iraq finds a way to get more oil out of the ground. The gloomiest of forecasts warns of $5 for a 42-gallon barrel of West Texas intermediate, the U.S. benchmark.

That would make a gallon of crude, which already is cheaper than water, less expensive than pretty much anything you could buy at a gasoline station convenience store, even a 25-cent gum ball.

Continued low prices would extend the fuel holiday for oil users, from motorists to manufacturers, who have reaped great benefits from the price drop that began shortly after the November 1997 decision by the 11-nation OPEC cartel to boost production.

Crude was then trading at about $23 a barrel, but it soon began to slip as demand in Asia dried up and a warm, El Nino-influenced winter depressed heating oil use. Oil and gasoline eventually hit historic lows when adjusted for inflation. The near-month contract price for West Texas intermediate fell to $10.35 last Dec. 21 on the New York Mercantile Exchange. The average price nationwide last year for unleaded regular self-serve gasoline was $1.03 a gallon, the lowest inflation-adjusted annual price in U.S. history, the U.S. Energy Information Administration said.

Rock-bottom energy prices were enough to help pull U.S. inflation in 1998, as measured by the consumer price index, below 2% for the first time in 12 years. Low prices for gasoline, heating oil and other petroleum products burned nearly a percentage point off the index during the year, according to the Bureau of Labor Statistics.

But the toll on oil producers has been enormous. Nearly 9% of U.S. petroleum industry workers, or 29,300, lost their jobs in 1998. Earnings for the year at major oil companies fell nearly a third overall from 1997, which was a record year for many companies, according to First Call Corp., a Boston firm that tracks earnings.

The Independent Petroleum Assn. of America, a Washington-based trade group for small producers, estimates that the U.S. government and the 33 states that produce oil and natural gas, including California, have lost more than $1.8 billion in royalties and taxes because of low energy prices.

Independent oil producers have been hurt the most, shutting wells producing more than 300,000 barrels a day, or about 5% of U.S. production, the group said.

“There’s a big difference between what producers are getting in the field and the West Texas intermediate price on the Nymex,” said Scott Espenshade, chief economist for the Independent Petroleum Assn. “We have third-generation oilmen in our association who say that this is the worst they’ve ever seen, even through their fathers’ and grandfathers’ times.”

Major oil companies plan to cut roughly $10 billion in costs in the next two years, said Steven A. Pfeifer, oil analyst with Prudential Securities. The pressure to slash costs is also behind the reshaping of the industry through the pending merger of Exxon Corp. with Mobil Corp., the recently completed union of British Petroleum Co. with Amoco Corp. to form BP Amoco and the acquisition by France’s Total of Belgium’s Petrofina to form Total Fina.

When this all will end hinges on a sustained upturn in oil prices. Predicting the direction of any commodity price is a perilous enterprise, and few in the business will admit to outright optimism.

“At this point, it’s hard to see this year being much of an improvement,” said Alan H. Struth, economist for Phillips Petroleum Co. in Bartlesville, Okla.

Kenneth W. Haley, director of energy forecasting for San Francisco-based Chevron Corp., keeps a valuable oil forecasting tool front and center on his desk: It’s a dart.

Chevron’s more sophisticated modeling tools have pegged crude at a $13.50-a-barrel average price for 1999. Like most other companies that make a living looking for oil and making products from it, Chevron has scaled back spending plans accordingly, focusing on only the most crucial projects.

Major oil companies have cut capital spending plans for 1999 by an aggregate 18%, analyst Pfeifer said. Such reductions, he said, are “sowing the seeds for an eventual recovery in oil prices” to an estimated average price for the year of $15 a barrel.

Anton of Pforzheimer & Co. says low oil prices lead to reduced production in three ways: Uneconomical wells operated by small, independent producers get “shut in,” perhaps never to reopen; the routine maintenance needed to combat the natural decline in every oil field is deferred; and investment in new projects is put off or canceled.

“If you’re an operator making 50 cents a barrel and a pump breaks that’s going to cost $10,000 to replace, you don’t replace it,” he said.

Most look to OPEC, which fills about one-third of the world’s oil needs of roughly 75 million barrels a day, to pop a plug in the market’s leaky situation.

Some 3 million barrels a day in production cuts were agreed to last year by 10 OPEC members (Iraq excluded) and several other large producers such as Mexico and Norway. Those reductions ultimately were not good enough, even when most of the countries were doing their best to comply with their promises back in October, when they achieved nearly 95% of their reductions. Cheating has since reduced compliance levels, reaching a low of about 75% in January, according to the International Energy Agency, a Paris-based group that monitors world oil markets.

(Iraqi exports are restrained by a United Nations-monitored oil-for-food program, which allows the country to sell $5.2 billion of oil every six months, and by the deteriorated state of its war-ravaged oil facilities. However, pressure is rising worldwide to remove restrictions from Iraq’s oil industry, and both the United States and France have proposed that the U.N. lift the ceiling on oil exports.)

What OPEC will decide next month is anybody’s guess, with some producers calling for stricter compliance and deeper cuts and others refusing to pump less.

Energy economist Philip K. Verleger Jr. spins one version of the future that is pessimistic in the short run, with Iraq rebelling against OPEC restraints and pumping wildly, driving oil down to $5 a barrel. If that happened, Verleger contends, OPEC would finally be stung enough to act effectively and sharply reduce production, boosting oil past $18 a barrel later in the year.

But if demand remains sluggish because of Latin America and Asia, prices could fall again.

“Dip and bounce--it’s cyclical,” said Verleger, who early last year was predicting an oil industry depression when others were still not alarmed. “It could be a very, very messy 24 months.”

Pfeifer of Prudential Securities and several other analysts see the same path for oil prices: If OPEC makes no further production cuts at its March 23 meeting in Vienna, prices for crude will be soft or even down in the first half of the year and firmer in the second half. If OPEC does agree to substantial cuts, prices would rise sooner and higher, he said.

George Beranek, an analyst with Petroleum Finance Co., a Washington-based consulting firm, sees prices falling after this month when Japanese refiners traditionally shut down for maintenance, reducing demand for oil in Asia even more. Also, he noted, the coldest part of the winter is nearly over.

The economies of Latin America and even U.S. economic performance are wild cards that could hurt oil demand, said James Smith, an energy economist at Southern Methodist University in Dallas.

“I’m not a real optimist on crude oil prices,” Smith said. “I think it’s unrealistic to look back at $20 a barrel.”

Oil guru Daniel Yergin declines to put numbers on the future price of crude but notes that movement eventually comes down to the play between how much is produced and how much is consumed.

“The two things that will start to put a floor under oil prices are an economic recovery in Asia--and you’ve got to keep your eye on 2000 there--and a falloff of production because of low prices, which we are already beginning to see,” said Yergin, chairman of Cambridge Energy Research Associates and Pulitzer Prize-winning author of “The Prize,” a history of the oil industry.

“Supply and demand ultimately work in both directions.”

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Slippery Slope

Since November 1997, when OPEC decided to increase production, the near-month-contract price of a 42-gallon barrel of West Texas Intermediate crude oil has moved mostly lower. Monthly closes and latest for a barrel of West Texas intermediate crude on the New York Mercantile Exchange:

Friday: $11.88

Source: Bloomberg News